Download Bank ownership and stability: Evidence from Germany

“The Crisis and How to Deal with It”
Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, Robin
Wells.
The New York Review of Books
Volume 56, Number 10 · June 11, 2009
Following are excerpts from a symposium on the economic crisis presented by The New York Review
of Books and PEN World Voices at the Metropolitan Museum of Art on April 30. The participants
were former senator Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros,
and Robin Wells, with Jeff Madrick as moderator.
—The Editors
Jeff Madrick: It was six months ago now that the Lehman debacle occurred, that AIG was rescued,
that Bank of America bought Merrill Lynch; it was about six months ago that the TARP funds started
being distributed. The economy was doing fairly poorly in much of 2008, and then fell off a cliff in the
last quarter of 2008 and into 2009, shrinking at a 6 percent annual rate—an extraordinary drop in our
national income. It is now by some very important measures the worst economic recession in the post–
World War II era. Employment has dropped faster than ever before in this space of time.
We have a three-front problem: a housing market that went crazy as the housing bubble burst; a credit
crisis, the most severe we've known since the early 1930s; and now a sharp drop in demand for goods
and services and capital investment, leading to a severe recession. What gives us the jitters is that all
of these are related. We have seen some deceleration in the rate of economic decline, and many people
are saying that "green shoots" are showing. What is the actual state of the economy, and do we need a
serious mid-course correction on the part of the Obama administration?
Bill Bradley: How far are we along in a recovery? When the market price of Citicorp drops from 60 to
1, and then comes back to 3, I don't think that's a recovery. Warren Buffett buys Goldman Sachs, and
after he buys, the price drops 45 to 50 percent, and if he's going to break even on the investment he's
got to earn 9 percent for the next twelve years, I don't think that's a recovery. The administration has
put in place measures that, if they were to work, could offer some hope.
What I'd like to suggest is that if they don't work, there's an alternative. The national government has
now made about $12.7 trillion in guarantees and commitments to the US financial sector, and we've
already spent a little over $4 trillion in this crisis. Some institutions such as Citicorp, for example,
received about $60 billion in direct assistance, and $340 billion in guarantees. So US taxpayers are
into Citicorp for around $400 billion. If we look out to June, July, and if we see that the PPIP [PublicPrivate Investment Program, created by Treasury Secretary Timothy Geithner] is not succeeding, that
the bank assets aren't being bought at levels that they should be bought from the books of banks, then
there is an alternative.
Think back to Citicorp. I looked at the ticker today: the market capitalization of Citicorp is $17 billion.
So the government could buy Citicorp for a fraction of what we've already obligated the taxpayer for.
And in buying Citicorp, as an example—there could be one or two others—the government would
announce in four to six months that it is going to sell the good assets of the bank back to the public. If
the government bought Citicorp for, let's say, $20 billion, what would it be worth if the government
sold the good assets back to the public? Surely, several times what it paid for it.
I don't mean selling these assets to hedge funds, although they can participate; but I would propose
offering them to any American who wants to invest in this good bank the opportunity to do so.
The prospect of that happening would bring very strong, positive influence on the development of the
whole economy. And what would the government then be left with? The bad bank—that is, the bad
assets that we're going through hoops now to try to get off the bank books. Instead the government
would have those assets and it could take fifteen to twenty years to clean them up. So I say I would
like to see the existing program work. But if it doesn't work, there is an alternative, and it's an
alternative in the long run in which the average guy in America could participate.
Niall Ferguson: This is the end of the age of leverage, which began, I guess, in the late 1970s, and
saw an explosive rise in the ratio of debt to gross domestic product, not only in this country, but in
many, many other countries. Once you end up with public and private debts in excess of three and a
half times the size of your annual output, you are Argentina. You know, it's funny that people refer all
the time back to the collapse of Lehman last September. Let's remember that this crisis actually began
in June 2007. It fully became clear in August of 2007 that major financial institutions were almost
certainly on the brink of insolvency to anybody who bothered to think about the impact of subprime
mortgage defaults on their balance sheets.
But we were in denial. And we stayed in denial until September, more than a year later, of last year.
Then we had the breakdown. Notice how psychological terms are very helpful when economics fails
as a discipline. After the breakdown, we came out of denial and we realized that probably more than
one major bank was insolvent. Then in September and October the world went into shock. It was
deeply traumatic.
Now we're in the therapy phase. And what therapy are we using? Well, it's very interesting because
we're using two quite contradictory courses of therapy. One is the prescription of Dr. Friedman—
Milton Friedman, that is —which is being administered by the Federal Reserve: massive injections of
liquidity to avert the kind of banking crisis that caused the Great Depression of the early 1930s. I'm
fine with that. That's the right thing to do. But there is another course of therapy that is simultaneously
being administered, which is the therapy prescribed by Dr. Keynes—John Maynard Keynes—and that
therapy involves the running of massive fiscal deficits in excess of 12 percent of gross domestic
product this year, and the issuance therefore of vast quantities of freshly minted bonds.
There is a clear contradiction between these two policies, and we're trying to have it both ways. You
can't be a monetarist and a Keynesian simultaneously—at least I can't see how you can, because if the
aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the
Keynesian policy must be to drive interest rates up.
After all, $1.75 trillion is an awful lot of freshly minted treasuries to land on the bond market at a time
of recession, and I still don't quite know who is going to buy them. It's certainly not going to be the
Chinese. That worked fine in the good times, but what I call "Chimerica," the marriage between China
and America, is coming to an end. Maybe it's going to end in a messy divorce.
No, the problem is that only the Fed can buy these freshly minted treasuries, and there is going to be, I
predict, in the weeks and months ahead, a very painful tug-of-war between our monetary policy and
our fiscal policy as the markets realize just what a vast quantity of bonds are going to have to be
absorbed by the financial system this year. That will tend to drive the price of the bonds down, and
drive up interest rates, which will also have an effect on mortgage rates—the precise opposite of what
Ben Bernanke is trying to achieve at the Fed.
One final thought: Let's not think of this as a purely American phenomenon. This is a crisis of the
global economy. I'd go so far as to say it's a crisis of globalization itself. The US economy is not going
to contract the most this year, even if the worst projections at the International Monetary Fund turn out
to be right; a 2.6 percent contraction is far, far less than the shock already being inflicted on Japan, on
South Korea, on Taiwan, to say nothing of the shock being inflicted on Europe. Germany is
contracting at something close to 5 or 6 percent. So we are faced not just with a problem to be dealt
with by American policy, we are faced with a crisis of global proportions, and it's far from clear to me
that the prescriptions of Dr. Friedman and Dr. Keynes together can solve that massive global crisis.
Paul Krugman: Let me respond to that a bit. Let's think about what is actually happening to the
global economy right now. On the one side there has been an abrupt realization by many people that
they have too much debt, that they are not as rich as they thought. US households have seen their net
worth decline abruptly by $13 trillion, and there are similar blows occurring around the world. So the
people, individual households, want to save again. The United States has gone from approximately a
zero savings rate two years ago up to about 4 percent right now, which is still below historical norms;
but suddenly saving is occurring.
That saving ought to be translated into investment, but the investment demand is not there. Housing is
flat on its back because it was overbuilt; housing bubbles collapsed not only in the United States, but
across much of Europe. Many businesses cannot get access to capital because of the breakdown of the
financial system. But even those that do have access to capital don't want to invest because consumer
demand is not there. Between the housing bust and the sudden decision of consumers to save, after all,
we have a world with lots of excess capacity. The GDP report that just came out says that businessfixed investment, non-residential fixed investment, essentially business investment, is falling at a 40
percent annual rate.
This causes a problem. There are lots of people who want to save, creating a vast increase in savings,
not only in the US but around the world, combined with a sharp decline in the amount that the private
sector is willing to invest, even at a zero interest rate, or rather even at a zero interest rate for US
government debt, which is what the Federal Reserve has the most direct impact on.
One way to think about the global crisis is a vast excess of desired savings over willing investment.
We have a global savings glut. Another way to say it is we have a global shortage of demand. Those
are equivalent ways of saying the same thing. So we have this global savings glut, which is why there
is, in fact, no upward pressure on interest rates. There are more savings than we know what to do with.
If we ask the question "Where will the savings come from to finance the large US government
deficits?," the answer is "From ourselves." The Chinese are not contributing at all.
Those extra savings are, in effect, the savings that America has wanted to make anyway, but that US
business is not willing to invest under current conditions. That is the way Keynesian policy works in
the short run. It takes excess desired savings and translates them into some kind of spending. If the
private sector won't do it, the government will. There is actually no contradiction between the Federal
Reserve's actions and the actions of the US government with a fiscal stimulus. It's very much
necessary to do both. By buying a lot of private securities, the Federal Reserve is essentially going out
there and playing the role that the private banking system is no longer playing properly; by engaging
in investment, the federal government is playing the role that businesses are not now willing to play.
All that debt-financed spending on infrastructure by the Obama administration is basically filling the
hole left by the collapse in business investment in the United States. There is not an excess demand for
savings that is going to drive up interest rates. The only thing that might drive up interest rates—and
this is a real concern—is that people may grow dubious about the financial solvency of governments.
Now, the great concern I have is that although we understand these things fairly well, there are thirtyeight Republican senators who say that the answer for the crisis is another round of Bush-style tax cuts
that will reduce revenues by $3 trillion over the next decade.
This crisis has been so large and the political process has been so sluggish that the difficulties have
been greater than expected. And yes, there are some green shoots. Things are getting worse more
slowly, but we have not managed to head off a crisis that could turn out to be self-reinforcing, and
leave us in this trap for many, many years.
Nouriel Roubini: It's pretty clear by now that this is the worst financial crisis, economic crisis and
recession since the Great Depression. A number of us were worrying about it a while ago. At this point
it's becoming conventional wisdom.
The good news is probably that six months ago there was a risk of a near depression, but we have seen
very aggressive actions by US policymakers, and around the world. I think the policymakers finally
looked into the abyss: they saw that the economy was contracting at a rate of 6 percent–plus in the US
and around the world, and decided to use almost all of the weapons in their arsenals. Because of that I
think that the risk of a near depression has been somewhat reduced. I don't think that there is zero
probability, but most likely we are not going to end up in a near depression.
However, the consensus is now becoming optimistic again and says that we are going to go from
minus 6 percent growth to positive growth in the second half of this year, meaning that the recession is
going to be over by June. By the fourth quarter of 2009, the consensus estimates that growth is going
to be positive, by 2 percent, and next year more than 2 percent. Now, compared to that new consensus
among macro forecasters, who got it wrong in the past, my views are much more bearish.
I would agree that the rate of economic contraction is slowing down. But we're still contracting at a
pretty fast rate. I see the economy contracting all the way through the end of the year, going from
minus 6 to minus 2, not plus 2. And next year the growth of the economy is going to be very slow, 0.5
percent as opposed to the 2 percent–plus predicted by the consensus. Also, the unemployment rate this
year is going to be above 10 percent, and is likely to be close to 11 percent next year. Thus, next year
is still going to feel like a recession, even if we're technically out of the recession.
The outlook for Europe and Japan, both this year and next year, is even worse. Most of the advanced
economies are going to do worse than the United States for a number of reasons, including structural
factors in Japan and weak policy response in the case of the Euro zone.
The problems of the financial system are severe. Many banks are still insolvent. If you don't want to
end up like Japan with zombie banks, it's better, as Bill Bradley suggested, to do what Sweden did:
take over the insolvent banks, clean them up, separate good and bad assets, and sell them back in short
order to the private sector.
Now, on the question of policy responses, there is no inconsistency between monetary easing and
fiscal easing. Both of them should be stimulating demand, and the monetary easing should be leading
also to restoration of credit. Of course, in a situation in which the economy is suffering not just from a
lack of liquidity but also problems of solvency and a lack of credit, traditional monetary policy doesn't
work as well. You also have to take unconventional monetary actions, and you have to fix the banks.
And we need a fiscal stimulus because every component of our economy is sharply falling:
consumption, residential investment, nonresidential construction, capital spending, inventories,
exports. The only thing that can go up and sustain the economy for the time being is the fiscal
spending of the government.
However, fiscal policy cannot resolve problems of credit, and it is not without cost. Over the next few
years it's going to add about $9 trillion to the US public debt. Niall Ferguson said it's the end of the
age of leverage. It's not really. There is not deleveraging. We have all the liabilities of the household
sector, of the banks and financial institutions, of the corporate sectors; and now we've decided to
socialize these bad debts and to put them on the balance sheet of the government. That's why the
public debt is rising. Instead, when you have an excessive debt problem, you have to convert such debt
into equity. That's what you do with corporate restructuring—it converts unsecured debt into equity.
That's what you should do with the banks: induce the unsecured creditors to convert their claims into
equity. You could do the same thing with the housing market. But we're not doing the debt-into-equity
conversion. What we're doing is piling public debt on top of private debt to socialize the losses; and at
some point the back of some governments' balance sheet is going to break, and if that happens, it's
going to be a disaster. So we need fiscal stimulus in the short run, but we have to worry about the
long-run fiscal sustainability, too.
George Soros: There are two features that I think deserve to be pointed out. One is that the financial
system as we know it actually collapsed. After the bankruptcy of Lehman Brothers on September 15,
the financial system really ceased to function. It had to be put on artificial life support. At the same
time, the financial shock had a tremendous effect on the real economy, and the real economy went into
a free fall, and that was global.
The other feature is that the financial system collapsed of its own weight. That contradicted the
prevailing view about financial markets, namely that they tend toward equilibrium, and that
equilibrium is disturbed by extraneous forces, outside shocks. Those disturbances were supposed to
occur in a random fashion. Markets were seen basically as self-correcting. That paradigm has proven
to be false. So we are dealing not only with the collapse of a financial system, but also with the
collapse of a worldview.
That's the situation that President Obama inherited. He's faced with two objectives. One, he must
arrest the collapse and, if possible, reverse it. Second, he has to reconstruct the financial system
because it cannot be restored to what it was. This is a new situation. When people see this crisis as
being the same as previous financial crises, they're making a mistake.
The interesting thing is that what needs to be done in the short term is almost exactly the opposite of
what needs to be done in the long term. Obviously the problem was excessive leverage. But when you
have a collapse of credit there's only one source of credit that is still credible, and that's the state: the
Federal Reserve and the Treasury. Then you have actually to inject a lot more leverage and money into
the economy; you have to print money as fast as you can, expand the balance sheet of the Federal
Reserve, increase the national debt. And that is, in fact, what has been done, which is the right thing to
do. But then once this policy is successful, you have to rein in the money supply as fast as you can.
I would say that policy has generally lagged behind events. We were behind the curve. Now that the
free fall is moderating, and the collapse has more or less occurred, I think there is hope that policy
will, in fact, catch up with events. The outcome of the stress test of the banks will be important,
because that's basically where the policy has been lagging behind—in recapitalizing the banks. And
that's where most of the confusion comes from.
Robin Wells: I want to go back to what Paul said about the global savings glut. The global savings
glut is what drove interest rates down to historically low levels. Housing is very sensitive to the
interest rate, and therefore a housing bubble was practically foreordained by an extended period of low
interest rates. But you'll also notice that the bubble in housing hasn't occurred just in the United States,
it's also occurred in Spain, Eastern Europe, and the UK; it's been in Ireland, it's been in Iceland. In
order to prevent us from reexperiencing this catastrophe in another, say, ten years, we need to look at
the origins of the global savings glut. Yes, there are some differences in how the bubbles were actually
manifested in the different countries, and those manifestations are important; but let's look for a
moment at the global savings glut in its entirety.
I think this story starts really in the Eighties. During the Reagan years, we experienced chronic fiscal
deficits, and we began to abdicate our responsibility to raise tax revenue that could sustainably finance
government. In order to do that, we had to borrow, and who did we borrow from? We borrowed from
countries that were running persistent trade surpluses. And as we continued to run these deficits with
these countries, there grew to be a symbiotic relationship, as Niall Ferguson says, this Chimerica.
But it was on several different fronts. There were the net exporters, such as China, Japan, and
Germany, and the net importers of capital, the largest, of course, being the United States. This import
of capital allowed us to consistently live beyond our means, first by running fiscal deficits, not raising
enough tax revenue to finance the government, and then also through, ultimately, the leverage that we
used in housing, and in commercial real estate, and in leverage buyouts. And this continued; it grew
because there was no point anywhere along the line at which anyone would say "halt."
The persistent imbalances led us to pretend that we could keep borrowing without having sufficient
tax revenue to pay for the government. And if your house prices are rising, if the stock market is going
up—which of course is going to happen if you have cheap money—it puffs up the value of the assets,
and disguises a lot of other structural problems such as rising inequality and corruption.
With this inflow of capital from abroad, the financial sector in the United States also became larger
and larger relative to the rest of the economy, with GDP tilted disproportionately toward the financial
sector.
How do we start to get out of this? In many ways we're almost adverse to bringing up the situation in
which we find ourselves with the net exporting countries. I thought it was quite interesting a few
weeks ago when many Chinese officials were saying that it was proper, and it was good economically,
that the US continue to run persistent trade imbalances with China, that the Chinese yuan did not need
to be appreciated, that we should continue doing the things we always have, and that the US should
make sure that the value of Chinese assets were not diminished by any change in the value of the
dollar. It should have been clear that this was not a sustainable relationship, but no one was willing to
say that.
So I think we're going to have to address these chronic global trade imbalances. You might very well
see a shift toward more protectionism. We're going to have to actually do something about raising
taxes so that we can sustain government from our own resources rather than depending upon
borrowing abroad. And we're going to have to start stepping back into our former role, one that we
abdicated, as managers and guardians in the global economy.
J.M.: I think most people think the US government did what it had to in adopting a serious stimulus,
despite the debt. Niall, why don't you respond to the comments, and then we'll have a little discussion
on that.
N.F.: Well, if you listened carefully to what Paul Krugman said, he actually agreed with me. Because
what he said was that everything is just fine as long as the financial credibility of the United States
isn't called into question, but my point is that it will be called into question. Of course it will.
According to the administration's crazily optimistic forecast for a recovery, it's going to be a 3 percent
growth rate next year, 4 percent the year after that, 4.6 percent the year after that. If you believe those
numbers, you'll believe absolutely anything, but they are there in the administration's budget
document. Even if those numbers turn out to be true, the federal debt will rise over the next five to ten
years to around 100 percent of gross domestic product.
But since those numbers are clearly wrong, and the trend growth rate of the US will be much closer to
1 percent than to 4, it seems reasonable to anticipate a much more rapid explosion of federal debt to
somewhere in the region of 140 or 150 percent of gross domestic product. Even if the private savings
rate rebounded to its highest point in the postwar period, it would still account for no more than 5
percent of gross domestic product. But this year's deficit, as I said earlier, is likely to be north of 12
percent of gross domestic product. So it doesn't quite add up.
The Fed has committed itself to buying $300 billion worth of treasuries this year, but clearly it will
have to buy a great many more than that. Remember, $1.7 trillion or so are coming onto the market.
And you assume that the credibility of the United States in the eyes of Americans, as well as foreign
investors, is going to withstand this? At some point the United States does start to look like a Latin
American economy, not only to people abroad but maybe to people at home. If the Fed's balance sheet
explodes to up to $3 or $4 trillion, who knows how big it could get. At what point do people stop
believing in the US dollar as a reserve currency, or even as a store of value for their own savings?
J.M.: Let's allow Paul and others to respond.
P.K.: The essence of this kind of recession is precisely that the amount that collectively we want to
save is greater than the amount that collectively we want to invest. That is the problem. You can't get
around that.
There is a very different question, which is the long-run solvency of the US government, and I do
worry about that. I would disagree very much with Niall about those numbers, but this is a factor that
should be taken into account. We are currently in debt about 60 percent of GDP. We have in the past
been as high as 100 percent of GDP at the end of World War II without having a crisis, but your
ability to go that high does depend upon people's belief that you will behave responsibly, and that is
somewhat in question. I hope it is less in question than it was in the past, now that we've had some
regime changes, but it is a problem.
N.R.: I think that the debate here is about what needs to be done in the short term versus the long term.
The lesson of the Great Depression is pretty clear: it started with the stock market crash of 1929, and it
actually became the Great Depression by 1933 for four reasons. One, we didn't believe in a countercyclical monetary policy. The money supply contracted rather than being eased. Interest rates were not
falling, and that made the credit crunch worse. Two, nobody believed in counter-cyclical fiscal policy.
The general theory of Keynes was written only in 1936; in the early 1930s, the government was
raising taxes and cutting spending in order to maintain a balanced budget. That made the recession
even more severe.
Three, there was a belief that banks should be allowed to collapse. Thousands of them collapsed, the
credit crunch became even worse. And four, by 1933, 75 percent of households had defaulted on their
mortgages; they couldn't pay them. So a stock market crash became a Great Depression. Then you add
currency wars internationally, trade wars, protectionism, and capital controls; then you had default by
countries and the rise of totalitarian regimens in Germany and in Italy, in Japan, and Spain, and we
ended up in World War II. So those are the consequences of not taking the right policy actions in the
short run.
I agree, however, that we have to worry about the long run. If we're going to finance budget deficits by
printing money, we may have high inflation, even risk of hyperinflation in some countries. That's what
happened in Germany in the 1920s during the Weimar Republic. We are having large budget deficits
and increasing the public debt, we don't know whether it's going to be $5 trillion or $10 trillion of
more debt. But there are only a few ways of resolving that debt problem: either you default on it as
countries like Argentina did; or you use the inflation tax to wipe out the real value of the debt; or you
have to raise taxes and cut government spending. And given the size of the deficits, over time that's
going to be a painful political choice to make. So we need the stimulus in the short run, but we need to
restore medium-term fiscal sustainability.
G.S.: Let's face it, for twenty-five years we have been consuming more than we have been producing.
This living beyond our means accumulated mainly in the housing sector and the financial sector, and
now those liabilities are being nationalized. It's a bit unfortunate that so far we have only nationalized
the liabilities of the banks, and not their assets. I think it's right that we are extending a government
credit to replace the collapsing credit, and we are currently in a deflationary situation. When the flow
of credit restarts, suddenly there will be a flip-flop where the fear of deflation will be replaced by the
fear of inflation. The pressure for interest rates to rise will be very, very strong, and the rise in interest
rates could choke off the recovery. And so we are facing a period of stop-go, or stagflation similar to
but more severe than what we faced in the Seventies. But that is a favorable outcome compared to
what would have happened if we hadn't done what we are doing.
About regulation, we have to start by recognizing that the prevailing view is false, that markets
actually are bubble-prone. They create bubbles. Therefore, they have to be regulated. The authorities
have to accept responsibility for preventing asset bubbles from growing too big. They've expressly
rejected that, saying that if the markets don't know, how can the regulators know? And, of course, they
can't. They're bound to be wrong, but they get feedback from the market, and then they can make
adjustments. Now, it is not enough to regulate the money supply. You have to regulate credit. And that
means using tools that have largely fallen into disuse. Of course you have margin requirements,
minimum capital requirements; but you actually have to vary them to counteract the prevailing mood
of the market, because markets do have moods. It should be recognized that exuberance actually is
quite rational. When I see a bubble beginning, forming, I jump on it because that's how I make money.
So it's perfectly rational.
It's the job of the regulators to regulate. However, we should try not to go overboard. While markets
are imperfect, regulators are even more imperfect: not only are they human, they're also bureaucratic
and subject to political influences. So we want to keep regulation to a minimum, but we have to
recognize that markets are inherently unstable.
N.R.: On this question of regulation, of course, we go into cycles, you know. We had the Great
Depression, and then we imposed many actually useful regulations, both on the financial system and
on the real economy. Some of them became excessive, and even before Reagan and Thatcher, Jimmy
Carter started deregulating some parts of the economy. Eventually policy makers started believing that
self-regulation is best; but that means no regulation. We believed in market discipline; but there is no
discipline when there is irrational exuberance. We relied on internal risk management models; but
nobody listened to risk managers when the risk takers were making all the profits in the banks; and we
relied on rating agencies which had massive conflicts of interest since they were being paid by those
that they were supposed to be rating. So the entire model of self-regulation and market discipline now
has collapsed.
We have to go to a world where there is greater prudential regulation and supervision of the financial
system. I think the challenge for the US economy is, can we grow without excessive credit and
leverage? Can we grow in a more sustainable way? And what are going to be the sectors of the
economy that give us sustainable, long-term growth? I think that's an open question.
P.K.: I think there are two big structural changes that we'd want to see. One is we need to reduce the
role of the financial sector in the economy. We went from an economy in which about 4 percent of
GDP came from the financial sector to an economy in which 8 percent of GDP come from the
financial sector, and in which at its peak 41 percent of profits were being earned by the financial
sector. And there is no reason to believe that anything productive happened as a result of all of that.
These extremely highly compensated bankers were essentially just finding new ways to offload risks
on to other people.
As I've written, we need a boring banking sector again. All of this high finance has turned out to be
just destructive, and that's partly a matter of regulation. But in the political economy there was also a
vicious circle. Because as the financial sector got increasingly bloated its political clout also grew. So,
in fact, deregulation bred bloated finance, which bred more deregulation, which bred this monster that
ate the world economy.
The other thing not to miss is the importance of a strong social safety net. By most accounts, most
projections say that the European Union is going to have a somewhat deeper recession this year than
the United States. So in terms of macromanagement, they're actually doing a poor job, and there are
various reasons for that: the European Central Bank is too conservative, Europeans have been too slow
to do fiscal stimulus. But the human suffering is going to be much greater on this side of the Atlantic
because Europeans don't lose their health care when they lose their jobs. They don't find themselves
with essentially no support once their trivial unemployment check has fallen off. We have nothing
underneath. When Americans lose their jobs, they fall into the abyss. That does not happen in other
advanced countries, it does not happen, I want to say, in civilized countries.
And there are people who say we should not be worrying about things like universal health care in the
crisis, we need to solve the crisis. But this is exactly the time when the importance of having a decent
social safety net is driven home to everybody, which makes it a very good time to actually move ahead
on these other things.
N.F.: Well, I tell you what, I feel depressed after what I've heard tonight. We are now contemplating a
massive expansion of the state to substitute for the private sector because that's the only thing Paul
thinks will deliver growth. We're going to reregulate the markets, we're going to go back to those good
old days. Where were you in the 1970s when all these wonderful regulations were in place? I don't
remember that going too smoothly. But what else are we going to do? We're going to print money.
Almost limitlessly we'll print money. That's going to be fine, too. And when we're done with that,
we're going to raise taxes. What a fabulous package we have in store for us. You know, back in late
2007, I was asked what my big concern was, and I said, "My concern is that we're going to get the
1970s for fear of the 1930s." It's very easy to forget, in your iron indignation at the failure of the
market, where the true mainsprings of economic growth lie. The lesson of economic history is very
clear. Economic growth does not come from state-led infrastructure investment. It comes from
technological innovation, and gains in productivity, and these things come from the private sector, not
from the state.
B.B.: As we look at the future, we also have to look at the mistakes policymakers made in the last ten
years. It's not news that people are greedy. But we made conscious decisions not to put limits on that
natural human impulse. What were the mistakes? In 1999, we allowed investment banks, banks,
insurance companies to combine: we eliminated the Glass-Steagall Act, which prohibited commercial
banks from operating as investment banks. Why was Glass-Steagall put into law? Because the last
time we didn't limit greed we got into trouble, the Great Depression.
The second mistake was in 1999, the explicit decision by the Clinton administration and Congress not
to regulate derivatives, in particular credit default swaps. In 2002 they were worth $1 trillion and today
they're worth $33 trillion, and that decision not to regulate derivatives created the following sequence:
you have mortgages; then a thousand mortgages are packaged and sold as a mortgage-backed security;
a thousand mortgage-backed securities are packaged and sold as a collateral debt obligation [CDOs];
then a thousand collateral debt obligations are packaged and sold as a CDO squared; and insuring each
one of those bundles are credit default swaps, which are a part of that $33 trillion. And our
government deliberately decided not to regulate this chain of investments.
One result was that the 374 people in the London office of AIG who were responsible for AIG
derivatives destroyed a company that had 116,000 employees in 120 countries. Why? Because there
was no regulation at all.
The third decision was in 2004. The SEC allowed banks to go from 10 to 1 leverage to 30 to 1
leverage. And guess what? Once they were allowed to do it, they did it. So if we're going to look at the
future, we might think of undoing those three mistakes.
Finally, we might want to remember that the chairman of the Federal Reserve is supposed to remove
the punch bowl from the party when the party gets out of control. And that did not happen in the
Greenspan years. The opposite happened.